Reserve Bank Governor Adrian Orr says mandatory climate-risk disclosure standards under development will help fill a void by providing more detail on identifying, pricing and allocating risk from climate change within the financial system.
In a speech on Monday on why climate matters to the Reserve Bank, Orr describes the financial system as a critical engine working to identify, price, and allocate risk.
"Climate risks are evolving, and the market is working to come up to speed on those risks. But historically, that engine hasn’t fully addressed potential risks from climate change," says Orr.
"This is partly because we simply do not know the true scope and scale of the environmental risks we take on during our daily economic activities. Transition risks have also proved elusive: it’s hard to identify a risk when the timing and magnitude of climate policies in New Zealand or overseas are unknown."
"Likewise, many of the material costs of our economic decisions are ‘externalised’, that is, borne by others including future generations. Solving the moral hazard of transition costs falling on the present generation, while the benefits of those actions, in reduced climate impacts, accrue to future generations, has proved a tall order," Orr says.
"What this means is that we will never have perfect information on the risks of climate change. However, the mandatory climate-risk disclosure standards being developed by the External Reporting Board (XRB) and regulated by the Financial Markets Authority (FMA), will help start closing some of those information gaps."
"Firms’ disclosure on how they identify and manage climate change risks will help to bring those risks into focus for management and investors alike. After all, it is what gets measured that generally gets managed. And it is far often better to imperfectly measure something than ignore it completely, in particular when it helps guide investor decisions. In measuring climate risk, climate disclosure can shed light not only on those risks, but also transition opportunities," says Orr.
Without adequate disclosure to help identify and price risks, Orr says change may be disorderly and much more difficult to manage.
"Historically, the financial system has not fully accounted for the consequences of climate change. But New Zealand’s financial history is still being written – and disclosure has the potential to be a key part of that story," he says.
The XRB is an independent Crown entity tasked with preparing and issuing accounting standards and audit assurance standards. Climate-related disclosures will be mandatory, from next year, for listed companies with a market capitalisation of more than $60 million, large licensed insurers, registered banks, credit unions, building societies and managers of investment schemes with more than $1 billion in assets, plus at least some Crown financial institutions via a letter of expectation from their relevant Minister.
The XRB's final consultation on the climate-related disclosure standards, which it says about 200 of New Zealand’s largest entities will need to report against from next year, is currently open. XRB CEO April Mackenzie says the disclosure standards are ultimately about driving investment and capital away from high-emissions activities and towards low-emissions activities.
"We are confident the disclosure regime we’ve developed will support that transition," Mackenzie says.
XRB plans to issue the standards in December, and for them to be effective from 1 January 2023, meaning they'll be effective for all climate reporting entity's next reporting periods.
Meanwhile in Monday's speech, Orr also noted the introduction of a climate change risk element into the Reserve Bank's annual solvency stress test of banks last year, by including a two-year North Island drought in the scenario.
"Our modelling showed that the drought, on its own, did not create undue stress. However, when combined with an economic downturn the drought caused a 40% increase in dairy loan defaults over four years, before returning to level similar to today. This result illustrates the importance of nonlinearities in financial impacts from climate change," Orr says.
This year's bank stress tests will assess the impact of rising interest rates and climate change on banks.
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6 Comments
Not sure what impact this will have on our current risks based on our built environment. Which is where our greatest risks exist I am thinking. Perhaps this will be picked up with the insurance companies covering these risks on an ongoing basis. Next I wonder how the risks from climate change will be factored the financial systems with regard to new subdivisions and infrastructure developments? Perhaps once again via these insurance companies which I presume underwrite these enterprises. How will this disclosure system capture any risks associated with ‘firms’ under $60m capitalisation. I am probably missing something obvious to others.
I did some consultancy work for a very large UK housing provider years ago. They were looking at reducing the cost of repairs, maintenance, insurance etc - in an era when flood risks (and insurance premiums) were ramping up in their area. It was clear from twenty years of data that they had already lost a fortune on insurance costs, and, critically, their stock was large enough for them to spread their risks internally with some relatively simple medium-term planning and management of reserves.
My point here is that 'NZ Inc' needs to look at the escalating and compounding risks from climate change and earthquakes and ask whether a commercial insurance model that simply extracts $1bn a year from the economy is really our best hedge against disaster?
Given the economic disasters rolling out in Germany and the UK the Reserve Bank should be stress testing climate policy not climate change. Or maybe just focus on inflation.
'Preliminary analysis suggests that climate change need not be a significant threat to the soundness and efficiency of the financial system, provided all risks are proactively analysed, understood (to the extent possible), communicated and appropriately factored into decision making from the outset. However, climate change could be a significant aggravating factor in the event of a broader negative shift in market sentiment or conditions.'
https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Financial%20stabilit…
Focus on inflation Adrian.
"How Bad Are Weather Disasters for Banks?
Federal Reserve Bank of New York Staff Reports, no. 990 revised January 2022
Not very. We find that weather disasters over the last quarter century had insignificant or small effects on U.S. banks’ performance. This stability seems endogenous rather than a mere reflection of federal aid. Disasters increase loan demand, which offsets losses and actually boosts profits at larger banks. Local banks tend to avoid mortgage lending where floods are more common than official flood maps would predict, suggesting that local knowledge may also mitigate disaster impacts."
Another lot on the CC bandwagon. How about Councils doing some homework on areas before they give the go ahead to a developer or is that up to the developer? With Council's being very risk averse likely not have any areas developed with a one in a thousand year flood event. At worst insurers/s won't insure those areas or put the premiums so high that people won't insure. Councils could pass the buck via a LIM where a recent event probability evaluation is done and 1 five hundred year etc is notified on the LIM. CC does not even have to be mentioned. New developments could also require the developer to state the event probability of floods.
Existing areas I believe are also being poorly evaluated negatively by insurance companies.
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